The relative risk of a proposed project is best accounted for by which of the following procedures?
A) Adjusting the discount rate upward if the project is judged to have above-average risk.
B) Adjusting the discount rate downward if the project is judged to have above-average risk.
C) Reducing the NPV by 10% for risky projects.
D) Picking a risk factor equal to the average discount rate.

Question

Quizplus · Accepted Answer

Adjusting the discount rate upward if the project is judged to have above-average risk is the best way to account for the relative risk of a proposed project. This is because a higher discount rate will reflect the higher risk associated with the project and result in a lower present value. This approach is consistent with the concept of risk-return tradeoff in finance where higher returns are expected for higher levels of risk.

The Relative Risk of a Proposed Project Is Best Accounted